Listen to our latest Talking Markets podcast to hear more. A transcript follows.
Christophe Vande Walle: Welcome Stephen and Anthony, a real pleasure having you both. I want to start our conversation by looking at the blockchain and digital assets space more from an equity-investor standpoint, with the first question for you, Anthony, how long have you been following the broader crypto and blockchain space, why is this technology so interesting, and why do you think investors should be paying attention to this space?
Anthony Hardy: My wife and I were actually just joking about this a couple of days ago, because last week was 10 years since both of us heard about Bitcoin for the first time. And, since we went on our first date as well. The first time I had heard the concept of a Bitcoin, we were on a hike in San Diego, it was a small group and it was funny—it was me and this other guy, we were both trying to ask my now-wife out. He was telling us about this internet money, I think Bitcoin was around a dollar at the time, and it sounded interesting, kind of funky, but, honestly, I should have been paying more attention at the time. I didn’t, I was too focused on trying to ask this girl out.
Fast forward 10 years, now I’m happily married to her, and he is a multi-billionaire with his crypto holdings. So, I like to joke that I got the girl, he got the coin, and my wife always likes to remind me, “don’t complain about doing the dishes because I could have married a billionaire.”
So, crypto has been on the radar screen for me for a long time. I’d say really over the past five to six years, I’ve gone deep down the rabbit hole and, in my role within the Franklin Equity Group and it is, in my view, one of the most fascinating trends in recent history, right up there with, kind of the adoption of cloud computing and even the internet.
And, the reason why—it’s a couple of reasons. One, right? Like, within the space of just over a decade, over a trillion dollars in value has been created. So, clearly something’s happening here. And then the other thing that’s just so interesting about it is that the range of outcomes is so wide. I mean, on the one hand, if you take the bullish view, we could be witnessing the birth of a new finance and internet ecosystem. And then obviously the bearish view, right, that all of this is made up and it’s all going to zero. So just the range of outcomes is wider than arguably anything else that we see in the broader markets. And so, when I think about presenting to our portfolio managers and helping them understand this space, I try to frame it with our long-term investment hats on. You know, what is going on here—what’s driving the growth in the sector and then what are the potential implications?
And, the takeaway, I like to leave them is, look, you can love it. You can hate it. But, like, the one thing you cannot do with the sector is ignore it. It’s too interesting. It’s potentially too impactful. Just please do not ignore it. Because while we can debate how much of an impact it will have it, at least in my view, from what I’m seeing in my seat, I don’t think this is going away. This innovation cannot be put in the bag. So, from our perspective is what can happen going forward from here?
There are really three key messages I’d share. One is the fact that, there is an actual technological breakthrough that’s happened here. There’s a reason why so much value has been created. And that main breakthrough is this idea of digital scarcity. What blockchain technology enables is for two people who have never met each other before to transmit value over the internet. And, this was not able to be done before. You either had to have a bank, or a payment processor or some sort of lender in the middle to enable the exchange of value on the internet. So blockchain enables this and, that’s why a lot of times you’ll hear parallels to the internet, right? It’s a decentralized protocol. It reduces friction, it enables innovation. Even the internet was criticized early in its days. But the key parallel in my view is that the internet enables the transfer of information. Whereas blockchain technology enables the transfer of value. And obviously there’s tremendous things you can do because of that.
The second reason why I think it’s interesting is the fact that while this will grow in cycles, there will be booms and busts. Really, if you take a step back and study the industry and look at the long-term trends, it is clearly up and to the right. Every time there is a bull market, it brings more capital, more developer interests, more media attention, more new users in the ecosystem. And, while some of that dies down a little bit in the subsequent bear markets, each time the industry just keeps on growing and growing and building. So, clearly that’s where this has been trending, even though we will see it be very, very cyclical and I’d expect that to continue.
And then the last reason is the fact that the markets that could potentially be impacted by crypto are arguably the largest markets in the world, specifically the market for money, the financial ecosystem and the internet. So, you know, each of those is worth tens of trillions of dollars in value, which is why it’s important to what’s going on in this space, just given the impact it could have on those industries.
Christophe Vande Walle: Let’s talk about some of the implications of blockchain and digital assets. And I will start with you, Stephen. What are some of the potential implications for asset management in your view, and how is Franklin Templeton looking at this space on the business side?
Stephen Dover: We look at this tall topic in two ways. One is the investment opportunities and the other is how it’s going to change us, our industry, and our investors. And we think the potential for disruption is huge. The asset-management industry and the financial industry in general is based on trust. And because we don’t have trust of each other, we have to have intermediaries between the investor and who is investing their money. And, blockchain and that technology allows for that intermediary to be disrupted and to go away and to reduce that friction and not unimportantly that cost. And, we think that will have major changes in how the financial services industries are organized in the future. Maybe a couple of examples of how to think about it is to look back in history into the Italian Renaissance, when the double-entry accounting system was first discovered or invented. That allowed the Italians, especially the Italian banks, to expand globally and have a trusted accounting system. Blockchain is in many ways similar to double-entry accounting. Or, even as we look at the internet, if we were to look at the internet back from, let’s say, 1997, 1998, we really should have looked at it two ways, one as investment opportunity, but also how is it going to affect our lives and our business? So, if the way that we manage and the way that we look at trust changes, what blockchain allows us to do is to customize value and to look at an entirely different range of investment opportunities, particularly those opportunities that are illiquid.
One of the opportunities is that if we were to look at how institutional investors invest versus how individuals invest, institutional investors have a great deal of access to illiquid opportunities. That might be things such as commercial real estate, which is often 10%, 15% of institutional portfolios. Blockchain provides an opportunity to provide that type of illiquid investment directly to individual investors and making an individual investor’s portfolio look very much like an institutional portfolio. Blockchain technology will allow asset managers to be much more direct to clients and not have to go through banks or an intermediary.
So, one of the industries that will be very much disrupted is the banking industry. Because of tokenization, blockchain would allow a lot of customization and we can set up portfolios that literally are individualized for each individual. Now, at Franklin Templeton we are looking at all of the opportunities that we think will happen along with digital currencies, as well with blockchain, and think that this will be a way that will define our industry and our business in the future.
Christophe Vande Walle: Well, thanks, Stephen. And, maybe building on that, Anthony, there’s so much going on in the broader landscape. In your view, what would be a helpful, let’s say framework, for tracking the evolution of the industry?
Anthony Hardy: There is so much going on in the ecosystem and what’s exciting about this trend is that, it has global implications. Innovation in this space is happening across the globe. It’s not just something that’s happening here in Silicon Valley and expanding. I mean, this truly is a global trend, which is why we think everyone should be at least paying attention and understanding what’s going on.
There’s kind of two main ways that I look at the space and have followed its evolution. The first is, who is trying to harness the power of this technology? And then, the early days call it the first, five, six years of the crypto ecosystem, right? It was kind of just let’s call them crypto-native companies, right? That they’re trying to build this new ecosystem outside of the traditional world. So that was kind of the first major group.
And then, call it 2015, 2016, that’s when traditional businesses have started to pick up that, “Hey, this is a great technology innovation, how can we harness it to help either advance our business or protect ourselves from disruption?” And so, really over the past five years, you’ve seen banks lean in heavily to this, you’ve seen the payments companies invest heavily in this space. The big exchanges realize the opportunities here, the creative futures contracts, and then asset managers, have been heavily investing in this space. So, that’s kind of the second big chunk of interest that came into the space.
And then, more recently in recent years call it, 2019 or so, you saw governments really start to take this seriously, think about the implications for them and develop their own strategies for how they can harness the power of this technology. So that’s one framework for using it. I guess there’s kind of two worlds, let’s call them.
There’s what we call the permissionless blockchain system. So that’s things like Bitcoin and Ethereum, things that happen outside of the traditional system. And then there’s what we call like permission system, where banks for example are trying to harness the power of this technology, but not necessarily through Bitcoin or Ethereum, like through blockchain networks that they build themselves. So, you’re kind of seeing two worlds and there’s been growth in both, obviously. The crypto side gets a lot more news flow, but point being there is a lot of activity in the space and that’s one way of tracking what’s going on in each of those sectors.
More meaningfully, for my job, trying to understand the implications for our equity investments is just understanding which markets crypto is going to have implications for. And as I mentioned, that the three big ones are money, finance and the internet. And so, for me, in order to take this view, where’s this industry going over the next, 20, 30, 40 plus years? You really kind of have to understand the evolution.
So, in the case of money is understanding, look, this kind of started out with the idea of being a digital peer-to-peer payment system but then it evolved to actually this is a great substitute for store of value. Oftentimes digital gold is what is referred to, and then what that’s evolved to is the launch of things like stable coins and central-bank digital currencies. So in each of these areas, there’s an evolution where there’s an idea, and then it’s almost like Lego blocks building where the industry continues to innovate and the use cases just continue to widen.
That’s in the money bucket in the finance bucket, like I said, it kind of started with incumbent players trying to figure out how can we leverage this blockchain technology. And then, when you think about what you can do with it, things like smart contracts enable you to program actions with money, again, all without an intermediary. It enables you to have digital representation of assets and make them more accessible and easier to trade. And then, kind of the culmination of the evolution that’s happening in finance, this idea of DeFi, which stands for decentralized finance, which is essentially part of the crypto ecosystem, that’s trying to build banking and lending and payments capabilities completely without intermediaries.
That’s one of the more interesting newer trends. And thein the realm of the internet, there’s this idea that if you look at some of the big tech companies, they’re actually extracting a lot of the value that occurs on the internet. And I guess from the crypto ecosystems’ point of view is can we leverage this technology to return the power to the people, to have the communities that help build these big networks capture more of the value? So there’s a lot of innovation happening with things like decentralized applications and this idea that blockchain technology can help create web 3.0 and what are the implications of that?
So, there’s an evolution in each one of these major categories. Maybe just to double click how we think about it. We don’t have time to go deep in each one of them, but, for example, how is this technology going to impact the market for money? And what I love about blockchain technology, is it forces you to ask what seemed like basic questions, but they’re very important is, what is money and what can be considered money in the future? If you go back thousands of years ago, the forms of money were things like cows, stones, pelts, salt, obviously eventually metal and then paper.
And, you start to see these very, very long-term patterns where you go from objects, to metals, to paper, and then it still seems like we’re in the middle innings of this shift to digital money. There’s still a lot of paper money in the ecosystem. And, we can debate what forms of digital money can there be? It is a very fascinating trend, like, at least from my seat, the use case that seems the most obvious, like I said, is this digital-gold narrative where, if you look at the properties of a store of value that gold and other precious metals have, things like Bitcoin share those properties, but then at the same time they’re digitally native and they’re programmable. So, they’re easy to interact with, especially in the growing internet economy. Our framework is like, okay, let’s understand each of these markets, how big are they, what potential penetration could some of these crypto assets have in each of these markets. And then, most importantly, what are the implications for the rest of the ecosystem and how does that impact our investment strategy?
Christophe Vande Walle: Now let’s talk a little bit about central-bank digital currencies. They have been getting a lot of attention recently, so turning back to you, Stephen, can you talk about what these are and what implications they could have?
Stephen Dover: Implications are huge. Geopolitical power of any country is very much based on its control of the currency. So, I strongly believe that governments are not going to allow independent currencies to devalue their own currencies. It’s interesting how much digitally we’ve evolved just in the last few years, for myself, now, I very rarely even carry cash, because even the smallest thing that I purchase, a coffee in the morning, I can now use my credit card for. So we already are living somewhat in a digital economy. That said, at least for the US dollar, there’s at least $1.4 trillion in cash circulating of US dollar. Most of that being in $100 bills. So, there is a very large, cash society out there in terms of some of that being illicit, but some of that being as a store of value.
So, I think what we see going forward are many countries—with China leading, Australia, New Zealand are also following, the US I think will follow behind—moving towards a digital currency. And again, that is a way for countries to go directly to its populace, and not using that intermediary of banks. So, it is something that’s very disruptive potentially to the banking system. So, what we see coming out of that is a lot of new regulation, which we welcome. The governments have to set up the playing field for how we’re going to deal with currencies. Governments are not going to allow digital currencies to happen without taxation. We’ve already seen some of that in many countries. So, taxation will be an important part of where we move forward with both central bank currencies, as well as any other currencies. We’ve seen recently some blackmail, if you will, of companies and payments being made in literally Bitcoin or other currencies. I think crime is actually something that is harmful to the legitimacy of cryptocurrencies and governments will step in and it’ll be another reason why we would have central-bank currencies as opposed to independent currencies. So, there’s great opportunity with these central-bank currencies, and it will, again, break down some of the intermediaries and as asset managers, we have to be aware of that and see where there are opportunities around that. I think this could happen, fairly quickly, I think just like the internet, maybe, when we looked at the internet in 2000, there were a lot of promises. There was a lot of hype, the market got over-extended, and then corrected. Something like that can very much happen in this space, but ultimately, we are living very much in an internet world now, and I think we’ll be living very much in a very different currency system within the next five, 10 or 20 years.
Christophe Vande Walle: Thank you very much for your time and insights, Stephen and Anthony.
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